In a new paper, entitled "Policy Responses to Corporate Inversions: Close
the Barn Door Before the Horse Bolts," the Economic Policy Institute's
(EPI) Thomas Hungerford looks at the reasons why the United States Congress
should immediately pass legislation to tackle corporate inversions, rather than
waiting for comprehensive tax reform.
Hungerford discusses policy solutions to halt the flow of US multinationals
that are being seen to use corporate inversions when merging with an offshore
counterpart to move their headquarters abroad. However, "if Congress does
not settle on a targeted legislative fix and do it soon, the US could essentially
lose much of its corporate tax base," the paper states.
The EPI notes that, while inversions are typically portrayed as a way of escaping
the relatively high US 35 percent statutory corporate tax rate, "corporations
have many ways of lowering their tax bill. Despite what you hear in the media,
inversions have never been primarily about fleeing high statutory corporate
Hungerford believes that "the principal reason for inverting is to avoid
paying taxes on foreign-sourced earnings held overseas – taxes already
owed to the Treasury. For these firms, inverting is a way of dodging their tax
bill, not a natural result of the US corporate tax rate."
"Most of the firms seeking to invert have a large stash of tax-deferred
earnings sitting offshore. These earnings are subject to the US corporate income
tax (with a credit for foreign taxes paid), but only when they are repatriated
to the US parent as dividends," the paper adds. "By inverting and
then using a variety of schemes, the firms can have access to these earnings
virtually free of US taxes. This is undoubtedly the primary motivation to invert."
In opposition to recent commentators who have suggested that comprehensive
tax reform to lower the US corporate tax rate is the only real cure for the
inversion problem, the EPI is therefore convinced that, given the way that reform
is likely to be structured, it will not fix the inversions problem by itself.
Hungerford points out that, "not only is it unlikely that tax reform will
pass before too many companies invert, but if tax reform is revenue neutral
(as most proposals are), it will lower the statutory tax rate but not the average
effective tax rate. Hence, corporate tax reform won't reduce the incentive companies
have to invert."
Instead, he recommends specific and immediate legislation to address the incentives
and ability of firms to invert. While "changes in tax regulations (which
the US Treasury Department could promulgate without congressional approval)
are a necessary stopgap measure to reduce the outflow of the US corporate tax
base, … only targeted legislation that reduces the incentives and ability
of firms to invert can truly protect the corporate tax base."
He recommends, for example, the rules that have already been suggested in Congress
and by the Administration, and that would require that current shareholders
of the US firm own less than 50 percent of the new merged foreign firm, rather
than 20 percent under current law, and that firms be treated as US corporations
if they are managed and controlled in the US and have significant domestic business
Additional measures could include preventing the practice known as "earnings
stripping," by denying interest deductions where US companies had debt
over a certain level, and preventing corporations from using tax-deferred offshore
cash in ways that benefit US shareholders without paying US taxes.
"If companies want to become foreign entities, then they should have to
actually become foreign entities," Hungerford concluded.